Stephen Bainbridge's Journal of Law, Religion, Politics, and Culture

08/17/2018

A Critique of Senator Elizabeth Warren's "Accountable Capitalism Act" (Part 7): Corporate political spending should be a board prerogative

In a WSJ op-ed today, Senator Elizabeth Warren defended her proposed "Accountable Capitalism Act." In a series of posts (linked here), of which this is the last, I have argued that this bill is a very bad idea. In this post, I address her proposal that "At least 75% of directors and shareholders would need to approve before a corporation could make any political expenditures."

In the first place, it is hardly surprising that the fiercely partisan Democrat Warren is backing this idea. The progressive left is convinced that corporate America is bankrolling the GOP and has been trying for years to shut down that funding stream. (I think the politics of corporate America is more complicated than that stereotype, but that's an issue for another post). See my post on Hillary Clinton's rather transparent effort to do so.

But let's set that issue aside and focus on the corporate governance aspects. Under current law, shareholders have no voting rights with respect to corporate political spending. The law in every state is clear that the business and affairs of the corporatiopn are to be conducted by the board of directors and the managers to whom the board delegates authority. Corporate law in this regard is a system of director primacy, not shareholder primacy. Shareholders have no more right to decide where the corporate spends its lobbying dollars than they do to decide where the corporation builds plants or what products the corporation makes. See, e.g., Paramount Commc'ns Inc. v. Time Inc., Nos. 10866, 10670 & 10935, 1989 WL 79880, at *30 (Del. Ch. July 14, 1989) (“That many, presumably most, shareholders would prefer the board to do otherwise than it has done does not, in the circumstances of a challenge to this type of transaction, in my opinion, afford a basis to interfere with the effectuation of the board's business judgment.”), aff'd, 571 A.2d 1140 (Del. 1990).

Put another way, the law recognizes that "Charitable contributions are made by a corporation in the exercise of discretion by the Board of Directors or proper officers, primarily for public relations purposes ...." Hotpoint, Inc. v. U.S., 117 F.Supp. 572 (CT.CL. 1954). Just so, political contributions are (and should remain) within the discretion of the board of directors to be used as they see fit to advance the corporation's interests.

State corporate law provides clearly that the corporation’s business and affairs are “managed by or under the direction of a board of directors.” The vast majority of corporate decisions accordingly are made by the board of directors acting alone, or by persons to whom the board has properly delegated authority. Shareholders have virtually no right to initiate corporate action and, moreover, are entitled to approve or disapprove only a very few board actions. The statutory decision-making model thus is one in which the board acts and shareholders, at most, react.

Shareholder voting thus is simply one of many corporate accountability mechanisms—and not a very important one at that. In theory, of course, shareholders could vote incompetent directors out of office. In the real world, however, so-called proxy contests are subject to numerous legal and practical impediments that render them largely untenable as a tool for disciplining managers. Accordingly, the product, capital, and employment markets are all far more important than voting as a constraint on agency costs. To the extent voting matters, it does so solely because it facilitates the market for corporate control. If agency costs get high enough, it will become profitable for some outsider to acquire a controlling block of shares and exercise their associated voting rights to oust the incumbent board.

... As Delaware’s Chancellor William Allen observed, our “corporation law does not operate on the theory that directors, in exercising their powers to manage the firm, are obligated to follow the wishes of a majority of shares. In fact, directors, not shareholders, are charged with the duty to manage the firm.” Paramount Communications Inc. v. Time Inc., 1989 WL 79880 at *30 (Del. Ch. 1989), aff’d, 571 A.2d 1140 (Del. 1990).

Allen further recognized that the fact that many, “presumably most, shareholders” would have preferred the board to make a different decision “does not . . . afford a basis to interfere with the effectuation of the board’s business judgment.” In short, corporations are not New England town meetings.

It's also worth remembering that the beneficiaries of Bebchuk's incessant pressing of ever expanding shareholder power will not be ordinary investors. Instead, as Roberta Romano observed with respect to union and public pension fund sponsorship of shareholder proposals:

It is quite probable that private benefits accrue to some investors from sponsoring at least some shareholder proposals. The disparity in identity of sponsors—the predominance of public and union funds, which, in contrast to private sector funds, are not in competition for investor dollars—is strongly suggestive of their presence. Examples of potential benefits which would be disproportionately of interest to proposal sponsors are progress on labor rights desired by union fund managers and enhanced political reputations for public pension fund managers, as well as advancements in personal employment. … Because such career concerns—enhancement of political reputations or subsequent employment opportunities—do not provide a commensurate benefit to private fund managers, we do not find them engaging in investor activism.[1]

Recent years have seen a number of efforts to extend the shareholder franchise. These efforts implicate two fundamental issues for corporation law. First, why do shareholders - and only shareholders - have voting rights? Second, why are the voting rights of shareholders so limited? This essay proposes answers for those questions.

As for efforts to expand the limited shareholder voting rights currently provided by corporation law, the essay argues that the director primacy-based system of U.S. corporate governance has served investors and society well. This record of success occurred not in spite of the separation of ownership and control, but because of that separation. Before changing making further changes to the system of corporate law that has worked well for generations, it would be appropriate to give those changes already made time to work their way through the system. To the extent additional change or reform is thought desirable at this point, surely it should be in the nature of minor modifications to the newly adopted rules designed to enhance their performance, or rather than radical and unprecedented shifts in the system of corporate governance that has existed for decades.

And Director Primacy and Shareholder Disempowerment, 119 Harvard Law Review (2006), which was a response to Lucian Bebchuk's article The Case for Increasing Shareholder Power, 118 Harvard Law Review 833 (2005). In that article, Bebchuk put forward a set of proposals designed to allow shareholders to initiate and vote to adopt changes in the company's basic corporate governance arrangements.

In response, I made three principal claims:

First, if shareholder empowerment were as value-enhancing as Bebchuk claims, we should observe entrepreneurs taking a company public offering such rights either through appropriate provisions in the firm's organic documents or by lobbying state legislatures to provide such rights off the rack in the corporation code. Since we observe neither, we may reasonably conclude investors do not value these rights.

Second, invoking my director primacy model of corporate governance, I present a first principles alternative to Bebchuk's account of the place of shareholder voting in corporate governance. Specifically, I argue that the present regime of limited shareholder voting rights is the majoritarian default and therefore should be preserved as the statutory off-the-rack rule.

Finally, I suggest a number of reasons to be skeptical of Bebchuk's claim that shareholders would make effective use of his proposed regime. In particular, I argue that even institutional investors have strong incentives to remain passive.